Emergency Update: How Bad Will Coronavirus Get for Stocks
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The stock market impact from Coronavirus and what to do with your stocks
In my video on Let’s Talk Money published February 19th (watch it here) I warned investors that the Coronavirus could be a much bigger weight on the stock market and potentially lead to the next crash.
The next day stocks started their slide that has destroyed more than $2 trillion of investor wealth…and they’re still falling!
The S&P 500 has officially entered a ‘correction’ with a drop of 10% from it’s peak. Corrections are common and not usually something to panic over but what’s frightening about this one is how fast it happened. It took just six trading days to hit that 10% drop.
And this is far from over. While the virus has slowed in China where it originated, the rest of the world is seeing increased rates of spread and officials from the Center for Disease Control (CDC) say it’s not a matter of if but a matter of WHEN the U.S. suffers an outbreak.
A vaccine is still six- to twelve-months away and this is only going to get worse!
I wanted to make this emergency update to explain how bad this can get for stocks and offer some ideas on what to do with your investments. Taking a step back and thinking clearly about how this affects your investments will help you avoid the panic-selling and the worst investing mistakes that I’m already seeing in the market. I’ll also share my plan for getting back into stocks and how I’m investing through the chaos.
How Bad can the Coronavirus Get for Stocks?
While the spread of the virus has slowed in China, the rest of the world is just starting to see cases increase. South Korea has seen a surge in reported cases and Japan is likely to see its own in the coming weeks.
The virus has yet to spread widely in the United States though the first non-travel related case was reported yesterday. This means the virus is spreading person-to-person here in the U.S. and it’s very likely will become a much larger problem over the next months. Only a handful of states have their own testing kits so many are forced to send samples to Atlanta which is causing delays and the actual number of cases in the U.S. is probably much higher than known right now.
We’ve yet to see the full economic impact of the virus on China or the rest of the world. It’s likely China’s GDP could fall from growth of around 6% to under 3% for the fourth quarter and even into the second quarter. This is worse than just a quick dip in the economy. China was already seeing record loan defaults and it wouldn’t take much to accelerate things and lead to a much bigger problem.
That hit to China’s economy will affect the rest of the globe through trade, product supplies and commodity prices. The world rushed to build cheap product supply in China and now that’s all backed up. Everyone from Apple to Nike and Microsoft have already warned that products won’t be developed on-time because of supply shortages out of China.
The bigger impact though will come as we see the virus spread outside China. South Korea and Japan are already cancelling school and telling people to stay home. Officials in the U.S. are making plans for school closures and large-area quarantines if the virus spreads.
Stocks were already expensive, as much as 25% overvalued before the outbreak started weighing on the market. In that same February 19th video, I showed the price-to-earnings for each sector and the S&P 500, almost all of which were historically expensive.
That means it’s not going to take much to send stocks down further. Later in the article, I’ll share my price-points on stocks where I plan on buying back into the market. The first one is at 15% from the recent peak and I’m fairly confident we’ll get there, which would be another 5% lower than the current trade.
If the virus spreads further into the United States and we start seeing larger-scale closures, this could easily become a 20%+ bear market. For that to happen, we would probably have to start seeing layoffs or furloughs by companies which would materially impact the economy.
What to do with Your Stocks to Protect against Coronavirus Crash
The important thing is not to panic-sell out of all your stocks. I know that’s easier said than done when the market is wiping out thousands of dollars in your nest egg every day.
If you prepared for stock market weakness with some cash or just have bonds you can sell to produce that cash cushion, you might try the strategy I share below. This can turn out to be a great opportunity to use that cash to get back into stocks at more reasonable prices.
If you were fully invested in stocks…and I really hope you weren’t, then I hesitate to suggest you sell some stocks to buy bonds at this point. Yes, I believe the markets will drop at least another 5% before this is over but I hate to recommend selling stocks after you’ve potentially already lost 10% of your money.
Whatever you do, do not sell completely out of your stocks. If you decide to build a bond or cash reserve in case things get worse, consider selling just 10% or 15% of your stock portfolio. This will give you that cash cushion but still hold onto some of the stocks for that long-term view.
Better is to just use the experience as a learning example. You should always have at least 15% of your money in bond funds and 5% or more in cash (along with 15% to 25% in real estate funds). This will not only provide a quick source of cash for emergencies but help to protect you from stock market crashes and give you the opportunity to invest at better prices.
When to Get Back into Stocks after Coronavirus
The good news, if there is any, is that the spread of Coronavirus in China seems to be slowing. If a country of 1.4 billion people can contain the spread then there’s hope that other countries can do so as well, especially with the early warning and preparations that China didn’t have.
As long as the economic impact from the virus does not start prompting companies to lay off workers, we should see a relatively quick rebound from the virus-related stock correction. If companies start furloughing or laying off workers though, this could lead us into a recession and a much deeper crash.
I’m planning for both.
There are four points at which I will be taking advantage of the Coronavirus selloff to invest. This allows me to take advantage of lower prices but the discipline to hold some cash back in case the market crashes further.
Since the end of last year, I’ve moved much of my portfolio to cash and other forms of protection. This has given me the opportunity to plan out how to take advantage of the virus-related selloff. My current portfolio is as follows:
- 25% in cash
- 10% in covered call options – this is where you sell a call option against a stock you own, giving someone the option to buy the stock at a set price but paying you the cash premium (watch this video for detail on the strategy)
- 20% in bonds and peer-to-peer loans – I realize defaults for p2p loans will increase in a recession but these are still bond-like and will provide a source of cash when I want to reinvest
- 15% in real estate and real estate funds
- 30% in stocks
Besides the large cash position, I’m continuing to deposit money into the account each month. This is hugely important! Resist the temptation to get frustrated or fear the markets and stop investing. Deposit your savings as you normally would so you build that cash to invest and take advantage of lower prices.
The points at which I plan on buying back into the stock market include:
- If stocks reach 15% from their peak (approximately 2878 on the S&P 500) – I will use 25% of my cash to buy stocks with covered call options against them. This means I’ll protect my downside with an extra 5% or so on the stocks buy collecting that call premium.
- If stocks reach 25% from their peak (approximately 2539 on the S&P 500) – I will use 35% of my remaining cash to buy stocks.
- If stocks reach 35% from their peak (approximately 2200 on the S&P 500) – I will use 50% of my remaining cash to buy stocks.
- If stocks reach 45% from their peak (approximately 1862 on the S&P 500) – I will use all remaining cash to buy back the calls on my stocks and invest.
With the market down 11% already and the spread of the virus in the United States just getting started, I feel confident we’ll see at least that first 15%-point triggered. It will take a fairly dramatic spread of the virus and economic impact to fall further to that 25%-point but this is where stocks start looking attractive on valuation and as a long-term investment. We may not hit that 25% or subsequent points but I want to hold my cash back just in case we do. The market is already overvalued and I don’t feel the need to be fully invested even after a ten- or fifteen-percent drop.
The Coronavirus is one of those Black Swan events that nobody could see coming but that could start happening more in the future. A globalized marketplace means the spread of these is much more likely and investors need to be constantly ready with a plan. Take a step back, keep an eye on the long-term and avoid making the panicked decisions that lose money.
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